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Wednesday, July 18, 2012

Why Devon Is Worth $83 Per Share

From guest blogger The Global Value Investor.....

Devon (DVN) is a energy company listed in S&P 500 and engages in exploration, development and production of oil and natural gas. Competitors include Chesapeake Energy Corporation (CHK), Encana Corporation (ECA) and EOG Resources (EOG). Devon has a market capitalization of $23.5 billion and revenues of $11.8 billion.

Risks refer to a price drop in the underlying commodities, particularly gas liquids as this article suggests. Now, missing analyst estimates is always a possibility, as is the decline in price of market traded commodities. Since I am long term oriented investor, I do not assign much weight to near term price fluctuations and suggest, investors use the current weakness in Devon, and stocks in general, to their advantage and increase their equity exposure.

Why I like Devon
From a value investor perspective, the stock is trading below intrinsic value. The company is achieving an operating margin of 44% and a decent, yet not spectacular, return on equity of 10.5%.

Investors sometimes point out the debt load of Devon which seems to be quite high at $11 billion dollars. However, they neglect the around $7 billion cash position on Devon's balance sheet, bringing its net debt position down to only $3.7 billion, or only 16% of current market value of equity. Factoring the cash position, Devon is significantly less leveraged than Chesapeake for example.

In fact, Devon's cash position allows for major capital expenditures for its US and Canadian operations that are going to drive EPS going forward. Currently, analysts estimate about 9.55% earnings growth per year over a 5 year period. EPS growth is expected to increase by over 30% over next year, which makes the investment proposition even more attractive.

Analysts estimate a 2013 EPS on average of $5.53. Applying a multiple of only 15x forward earnings (which is conservative because it still discounts Devon's strong cash flow prospects from its US operations, its high level of proven reserves and strong balance sheet) would yield an intrinsic value estimate of $82.95 - representing about 43% upside potential.

Chart traders may also find this natural gas play interesting. The stock has just rebounded from its lower bound trend canal at just below $55 and regained strength after testing its support level. The stock now sits just under the upper bound of its short term trend canal that it defined in April, when the stock started sliding downwards from its 52 week high.

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